Financial Accounting John J. Wild Seventh Edition John J. Wild Seventh Edition Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Chapter 11 Reporting and Analyzing Equity

Advantages Separate legal entity Limited liability of stockholders Transferable ownership rights Continuous life Lack of mutual agency for stockholders Ease of capital accumulation Disadvantages Governmental regulation Corporate taxation Advantages Separate legal entity Limited liability of stockholders Transferable ownership rights Continuous life Lack of mutual agency for stockholders Ease of capital accumulation Disadvantages Governmental regulation Corporate taxation Characteristics of Corporations C1 11-3

Ultimate control Stockholders usually meet once a year Organizing and Managing a Corporation Selected by a vote of the stockholders Overall responsibility for managing the company C Corporate Organization Chart Chief Fin. Officer Vice President Finance Vice President Production Vice President Marketing President Board of Directors Stockholders

Basics of Capital Stock Total amount of stock that a corporation’s charter authorizes it to sell C1 Total amount of stock that has been issued or sold to stockholders 11-5

Par value No-par value Stated value Classes of Stock C $1 par

Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Record: 1.The cash received. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Paid-In Capital in Excess of Par Value, Common Stock. Record: 1.The cash received. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Paid-In Capital in Excess of Par Value, Common Stock. Issuing Par Value Stock at a Premium P1 11-7

Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. P Issuing Par Value Stock at a Premium

P Issuing Par Value Stock at a Premium

Record: 1.The asset received at its market value. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Paid-In Capital in Excess of Par, Common Stock. Record: 1.The asset received at its market value. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Paid-In Capital in Excess of Par, Common Stock. Issuing Stock for Noncash Assets Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. P

Issuing Stock for Noncash Assets Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. P

To pay a cash dividend, the corporation must have: 1. A sufficient balance in retained earnings and 2. The cash necessary to pay the dividend. Cash Dividends P

Three important dates Date of Declaration Record liability for dividend. Dividends Date of Record No entry required. Date of Payment Record payment of cash to stockholders. P Cash Dividends

Date of Declaration Record liability for dividend. Dividends On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. Entries for Cash Dividends P

Date of Record No entry required. Entries for Cash Dividends On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. No entry required on February 19. P

Date of Payment Record payment of cash to stockholders. Entries for Cash Dividends On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. P

The corporation distributes additional shares of its own stock to its stockholders without receiving any payment in return. Stock Dividends Why a stock dividend? Can be used to keep the market price of the stock affordable. Can provide evidence of management’s confidence that the company is doing well. Why a stock dividend? Can be used to keep the market price of the stock affordable. Can provide evidence of management’s confidence that the company is doing well. HotAir, Inc. Common Stock 100 shares $1 par P

Small Stock Dividend Distribution is  25% of the previously outstanding shares. Capitalize retained earnings for the market value of the shares to be distributed. Small Stock Dividend Distribution is  25% of the previously outstanding shares. Capitalize retained earnings for the market value of the shares to be distributed. Stock Dividends Large Stock Dividend Distribution is > 25% of the previously outstanding shares. Capitalize retained earnings for the minimum amount required by state law, usually par or stated value of the shares. Large Stock Dividend Distribution is > 25% of the previously outstanding shares. Capitalize retained earnings for the minimum amount required by state law, usually par or stated value of the shares. P

Here is the stockholders’ equity section of Quest’s balance sheet prior to the declaration of a small stock dividend. Recording a Small Stock Dividend P

On December 31, 2013, Quest declared a 2% stock dividend, when the stock was selling for $10 per share. The stock will be distributed to stockholders on January 20, Let’s make the December 31 entry. Recording a Small Stock Dividend 100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2, ,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000 P Temporary equity account

Before the stockdividend. After the stockdividend. P Same amount

Router, Inc. shows the following stockholders’ equity section just prior to issuing a large stock dividend. Recording a Large Stock Dividend (greater than 25%) P

On December 31, 2013, Router declared a 40% stock dividend, when the stock was selling for $8 per share. State law requires that large stock dividends be capitalized at par value per share. 50,000 × 40% = 20,000 shares × $1 par value = $20,000 Recording a Large Stock Dividend (greater than 25%) P

A distribution of additional shares of stock to stockholders according to their percent ownership. Common Stock $10 par value 100 shares Old Shares New Shares Common Stock $5 par value 200 shares Stock Splits (Example of a 2 for 1 Stock Split) P

Before the 2-for-1 split, the stockholders’ equity section of the balance sheet looks like this: Stock Splits P

After the 2-for-1 split, the stockholders’ equity section of the balance sheet looks like this: No accounting entry is made. No accounting entry is made. Stock Splits P

A separate class of stock, typically having priority over common shares in... Dividend distributions Distribution of assets in case of liquidation A separate class of stock, typically having priority over common shares in... Dividend distributions Distribution of assets in case of liquidation Usually has a stated dividend rate Normally has no voting rights Preferred Stock C

Vs.NoncumulativeCumulative Dividends in arrears must be paid before dividends may be paid on common stock. Undeclared dividends from current and prior years do not have to be paid in future years. Cumulative or Noncumulative Dividend Most preferred stock is cumulative. C

Example: Consider the following stockholders’ equity section of the balance sheet The board of directors did not declare or pay dividends in In 2014, the board of directors declare and pay cash dividends of $42,000. Cumulative or Noncumulative Dividend C

Cumulative or Noncumulative Dividend C

Reasons for Issuing Preferred Stock To raise capital without sacrificing control. To boost the return earned by common stockholders through financial leverage. To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low. To raise capital without sacrificing control. To boost the return earned by common stockholders through financial leverage. To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low. C

On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000. Purchasing Treasury Stock Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet. Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet. P

On June 30, Whitt sold 100 shares of its treasury stock for $4 per share (the same price it paid for it originally). Selling Treasury Stock at Cost $8,000 ÷ 2,000 shares = $4 cost per treasury share P

On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per share. (they originally paid $4 per share). Selling Treasury Stock Above Cost P

On August 27, Whitt sold an additional 400 shares of its treasury stock for $1.50 per share. (It originally paid $4 per share). On August 27, Whitt sold an additional 400 shares of its treasury stock for $1.50 per share. (It originally paid $4 per share). Selling Treasury Stock Below Cost P

Retained earnings is the cumulative amount of reported net income less any net losses and dividends declared since the company started operating. Statement of Retained Earnings C

Legal Contractual Most states restrict the amount of treasury stock purchases to the amount of retained earnings. Most states restrict the amount of treasury stock purchases to the amount of retained earnings. Loan agreements can include restrictions on paying dividends beyond a certain amount of retained earnings. Loan agreements can include restrictions on paying dividends beyond a certain amount of retained earnings. Restricted Retained Earnings C

A corporation’s directors can voluntarily limit dividends because of a special need for cash such as the purchase of new facilities. Appropriated Retained Earnings C

Correction of material errors in past years’ financial statements. If an amount is incorrectly expensed, depending on the error, the amount is either added to or subtracted from retained earnings. Prior Period Adjustments C

Statement of Stockholders’ Equity This is a more inclusive statement than the statement of retained earnings. C

Options are given to key employees to motivate them to: Focus on company performance Take a long-run perspective Remain with the company. Options are given to key employees to motivate them to: Focus on company performance Take a long-run perspective Remain with the company. Stock Options C

Earnings per share is one of the most widely cited items of accounting information. Earnings per Share Basic earnings per share = Net income - Preferred dividends Weighted-average common shares outstanding A

This ratio reveals information about the stock market’s expectations for a company’s future growth in earnings, dividends, and opportunities. If earnings go up, will the market price of my stock follow? Price-Earnings Ratio Price- earnings ratio = Market value (price) per share Earnings per share A

Tells us the annual amount of cash dividends distributed to common stockholders relative to the stock’s market price. Dividend YieldDividendyield= Annual cash dividends per share Annual cash dividends per share Market value per share A

Reflects amount of stockholders’ equity applicable to common shares on a per share basis. Book Value per Share—Common Book value per common share = Stockholders’ equity applicable to common shares Number of common shares outstanding A

Reflects amount of stockholders’ equity applicable to preferred shares on a per share basis. Book Value per Share—Preferred Book value per preferred share = Stockholders’ equity applicable to preferred shares Number of preferred shares outstanding A

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